Used Car
Leases. . .
Be Really, Really Careful!

Should You Ever Lease a Used Car?

Notwithstanding the name of this
article, a used car with reasonable lease terms can be a good
deal. We don't want to scare you away from considering a lease
on a used car.

We do want you to know what's
important in order to make an informed decision as to whether a
used car lease is right for you and if so, that you know how to
make the lease a successful one.

Used: No Stigma Here

In the not-too-distant past,
buying a used vehicle carried some sort of social stigma. If you
couldn't afford a new car, then obviously you weren't doing too
well financially. A new car carried with it some sort of
perceived status.

While still true to some extent,
a new car clearly does not carry the social significance it once
did. New cars and trucks look and perform well for many years.
Twenty years ago the 100,000 mile mark was a full lifetime for
any vehicle. Today, we expect that same 100,000 miles to be
trouble - and sometimes maintenance - free. Now, 150,000
miles-plus is generally considered to be the useful life of a
well maintained vehicle.

In today's market, a vehicle with
50,000 miles is not a high maintenance hunk of iron with half
its life gone. It's now viewed as a low mileage vehicle just
getting warmed up. More and more people of all income levels are
choosing used vehicles for their transportation needs. They have
come to the conclusion that used is the smart buy -- or lease.
The non-traditional used car buyer is driving the used market.

Given this growing interest,
manufacturers and finance companies are tripping all over
themselves trying to tap into this market by offering leases on
used vehicles. Of course, the marketing folks at these companies
have thrown their two cents in, so now you'll be comforted to
know that you are buying a pre-owned vehicle, not a dirty old
used one.

Currently less that 5% of used
vehicle retail transactions are handled through leases, as
opposed to about 30% for new vehicles. Used vehicle leasing
(along with subprime financing) is considered one of the last
high-growth areas of automotive finance, and you can expect it
to grow in the years to come.

The Concept of Leasing

Although this is not intended to
be an exhaustive study of leasing, Used Cars felt it was
important to cover the basic concepts. Many consumers are
woefully uneducated about what a lease is, not a good thing when
entering into a lease!

Most of the leasing concepts,
benefits, and pitfalls are the same for used cars as they are
for new cars. All the same terms apply, and the principles used
to negotiate a good lease deal on a new car also apply to used
vehicles. You need to understand three basic concepts behind a
lease:

You are renting the vehicle. You
do not own it.

You are paying for the
depreciation of the vehicle during the time you have it.

You are also paying interest
(often called a money factor) on the full value of the
vehicle as determined in the lease.

The downside remains the same:
perpetual payments and higher overall transportation costs over
the long run. However like a new car lease, leasing a used car
can put you into more car for the same monthly payment and to
some people that's worth the price of admission. And when you
opt for no capitalized cost reduction (something we highly
recommend) you get the benefit of freeing up cash for other
purchases. Or if you're really disciplined, you can invest it
and hopefully help offset the finance charges you are incurring
on the lease.

For an excellent source of
leasing information, A Consumer Guide to Vehicle Leasing can
be obtained free of charge from the U.S. Government. Call (202)
452-3244 or visit their website at http://www.bog.frb.fed.us/pubs/leasing/.

Who Really Benefits?

With the popularity of new car
leasing soaring, leasing companies and manufacturers are facing
an ever-increasing glut of clean, late-model off-lease vehicles.
The traditional way of disposing these vehicles, dumping them at
auction, depresses their wholesale and retail values. This is
not an ideal situation for these finance sources, as their
objective is to recoup as much of the original value of the
vehicle as possible.

You can rest assured that two of
the primary objectives of the various used car leasing programs
available, including the many "certified" programs, have nothing
to do with your benefit. They are to extend the profit cycle of
the vehicle for the leasing company, the manufacturer, and the
dealer, and to maintain the residual values on new cars and
trucks.

What does a residual value on a
new car have to do with a used car lease? High residual values
on new models benefits finance companies, manufacturers, and
dealers in two ways. First, all other factors being the same, it
will help them lease more new vehicles because they are able to
offer a lower lease rate for a given capitalized cost (what the
vehicle costs you). Remember, depreciation is the biggest
component of what you are really paying for in any lease. The
less depreciation, the less your monthly payment needs to be to
cover it. Alternatively, a higher residual lets dealers sell or
lease that model closer to the manufacturers suggested retail
price (MSRP) -- or even above -- while still maintaining a
competitive monthly payment.

To simplify the picture, high
residuals give the dealer more room to play with the price --
and thus profit -- when negotiating with an uneducated consumer.
And the lower the lease rate the finance companies can offer
(while maintaining profitability), the more vehicles they can
lease.

Still, all of this doesn't mean
that you can't negotiate a reasonable deal. You just have to
know what to look for.

Warranty Issues

There are many claims with
regards to warranty coverage on leased vehicles, particularly if
the vehicle has been "certified". Look closely. Some of these
vehicles do come with rather extensive extended coverage that
does indeed offer value-added to the vehicle. However, others do
not. Often the "extended" coverage is nothing more that the
remainder of the original factory warranty.

Used Cars recommends that you get
a list of what is covered -- and what isn't -- in writing. You
should also get in writing what the term of coverage is on the
specific vehicle you are considering. Don't settle for the
generic marketing brochure that talks in general and sometimes
vague terms. You need to see specifics about the vehicle you are
looking at.

If you determine that the scope
and quality of the coverage is acceptable, the next issue you
need to address is the lease term. NEVER LEASE A USED VEHICLE
BEYOND THE WARRANTY PERIOD. We cannot emphasize this enough.

As an example, say you have your
eye on a two year old car that offers lease terms within your
budget. The term of the lease is for three years, but the
warranty coverage is only good for two more years. This leaves
you exposed for a full year to any kind a mechanical breakdown,
and that is a significant difference from most new car leases,
which are fully covered during the length of the lease.
Transmission goes? That'll be $2000 please. Waterpump? $200. ABS
sensor shot? $650, thank you very much.

Yes, you'd still have to shell
out the money if you had purchased the car. The difference is
that you're shelling out the money for somebody else's car.
Having done that, you may feel compelled to purchase the car
at lease end. The problem with that is that you'll end up paying
far more for the car than if you had simply purchased it to
begin with. Not a pretty picture, is it? Used Cars does not feel
that exposing yourself to potential mechanical repairs is worth
the risk of leasing a used car that does not cover full warranty
coverage through the full lease term.

Service Issues

Ok, let's assume that you've got
the warranty issue covered. Good coverage will be in force the
entire life of the lease. You still need to take into
consideration service costs, which are not insignificant with
today's sophisticated and complicated vehicles. Timing chains,
tires, batteries, brakes, etc. will in all likelihood need to be
renewed during a two-or three-year lease on a two- or
three-year-old vehicle. Although not to the degree of the
warranty scenario, again you have to ask yourself if you want to
be putting money into someone else's vehicle.

I'm In! What do I Need to Know?

No doubt about it, late-model
used vehicles offer tremendous value. Taken from a purely
logical position, however, a used car lease is not the best way
to take advantage of current market conditions. Interest rates
are low, and down payment requirements are very liberal on
late-model used vehicles. Buying it and keeping it will save you
thousands of dollars in the long run.

But you've considered the above
and have decided to lease a used vehicle (I need that
Lexus!). You've got the warranty issue covered, and the service
issues don't bother you. What do you need to know?

First of all, you still need to
negotiate the price of the vehicle. Used Cars lists market
values for almost all domestic and import vehicles sold in the
US, so use this magazine as a guide. Do not let the dealer sell
you on low monthly payments and that the value doesn't matter in
a lease.

You should always know the
following: term, price, interest rate (also known as the money
factor), residual value, up-front fees, taxes, lease-end fees
such as excess mileage (if any), and the annual mileage
allowance. Also check to see if there is a mileage credit for
unused miles. Do not sign anything unless these are all clear to
you. Since 1998, dealers are required by law (Regulation M) to
clearly disclose the variables that affect the cost of a lease.

The theory behind a lease is that
you only pay for what you use. A lease will amortize only the
difference between the capitalized cost and the residual value.
You will pay interest charges, however, on the full capitalized
cost. Below is a simple rate calculation to help illustrate what
you'll be seeing.